Maybe you were one of the first to invest in Bitcoin. Maybe you’re still deciding whether buying and trading digital assets fits into your overall investment strategy. Either way, if you’re like most people, you’ve likely asked yourself this question: how does cryptocurrency work?
You understand what it is—sort of.
You know where it’s stored—kind of.
You feel confident in the security of your investment—uhhh…
Wherever you fall on the spectrum of understanding how cryptocurrency technology works, let’s take a step back and invite some honesty into this conversation. Because when it comes to Bitcoin, blockchain and the endless stream of moving parts involved with crypto trading—it’s okay to raise your hand and admit you aren’t 100 percent sure. And when you finally do, you’ll realize you are far from alone.
Hands are up, curiosity is piqued, and it’s time to get into it.
Ready? Let’s go!
How does cryptocurrency work?
Why, we’re so glad you asked! Cryptocurrency is a tough concept for even veteran investors and techies to wrap their heads around. So before we take a deep dive into how cryptocurrency technology works, let’s start with a few of the basics:
What is cryptocurrency?
As its name implies, cryptocurrency is a form of currency. Unlike fiat currency (feel free to read more about traditional forms of currency here) which is government controlled, country-specific, and a physical piece of paper or coin—cryptocurrency is borderless, decentralized, and completely virtual.
What happens when a transaction is made with cryptocurrency?
While you don’t need to understand the full functionality of crypto to use it, a bit of research and due diligence can go a long way!
Here’s a high-level overview of what goes down when a peer-to-peer crypto transaction takes place:
- A transaction is sent between peers using a cryptocurrency wallet.
- The person initiating the transaction transfers the balance from one public address (account) to another using wallet software.
- A private key (password) associated with the account is necessary to successfully transfer funds.
- When a transaction is complete, it’s broadcast on the crypto’s network and lined up to be added to the public ledger (blockchain). This process is encrypted, meaning that the people who make the transactions (not the amount itself) are kept anonymous.
- Miners then add the transaction to the blockchain sequentially for permanent public viewing.
Once the transaction is complete, the person on the receiving end of this equation receives a unique set of keys which are associated with a certain amount of cryptocurrency. To help clarify, keys can be thought of like bank accounts: whoever owns the account (keys), owns the money inside (cryptocurrency).
Where does my money go and how do I get it?
Cryptocurrency is virtual, not physical. When you purchase bitcoin or someone sends you crypto, you won’t receive a piece of paper or coin that can be used to pay for goods and services.
For many, that begs another important two-part question: Where does my money go, and how can I get it? Digital wallets are used to store virtual currency and house public keys (needed for receiving funds) and private keys (needed for spending funds).
Types of storage include hot storage (less secure because it’s connected to the internet) and cold storage (not connected to the internet and considered safer). Within these two categories exist a variety of options, each having its own list of pros and cons.
Once safely stored, you can access your crypto to buy goods and services, trade for different assets, send money to peers, and more. The list of how to spend and access crypto seems to grow everyday, increasing the flexibility and appeal of investing in digital currency.
What is Blockchain and how is it connected to cryptocurrency?
Another great and highly important question.
Blockchain technology powers the entire crypto ecosystem. And while it’s often confused as such, blockchain is not bitcoin and bitcoin is not blockchain. In fact, blockchain technology is used to support a variety of non-crypto related projects like smart contracts and advanced cybersecurity, just to name a few.
Relating back to cryptocurrency, Paul Dughi explains it this way: “Blockchain is the technology the underpins digital currency (Bitcoin, Litecoin, Ethereum, and the like). The tech allows digital information to be distributed, but not copied. That means each individual piece of data can only have one owner.” Once a record has been added to the chain it is very difficult to change.”
If this explanation still has you scratching your head, we encourage you to check out this very detailed visual of how blockchain works, or visit a past blog article that dives deeper into the nuances of blockchain technology.
What else do you want to know?
The world of cryptocurrency is an exciting, ever-evolving one. Packed with advanced concepts, complex technological applications, and a non-traditional way to acquire, send, spend, and save money—there’s always something new to learn about crypto.
It’s our goal to offer our readers highly valuable, insightful, and educational information on the crypto ecosystem.
Still find yourself wondering, “how does cryptocurrency work?” or have another pressing question? Feel free to add it in the comments below.
Who knows, maybe your question will be the topic of a future blog post!